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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549


FORM 10-Q

For the Quarter Ended March 31, 2002   Commission File No. 000-21429

ArQule, Inc.
(Exact Name of Registrant as Specified in its Charter)

Delaware
(State of Incorporation)
  04-3221586
(I.R.S. Employer Identification Number)

19 Presidential Way, Woburn, Massachusetts 01801
(Address of Principal Executive Offices)

(781) 994-0300
(Registrant's Telephone Number, including Area Code)


        Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ý    NO o

        Number of shares outstanding of the registrant's Common Stock as of April 30, 2002:

Common Stock, par value $.01   21,219,052 shares outstanding




ArQule, Inc.

Quarter Ended March 31, 2002

Table of Contents

 
   
  Page
PART I—FINANCIAL INFORMATION    
Item 1—Unaudited Consolidated Financial Statements    

 

 

Consolidated Balance Sheet
March 31, 2002 (Unaudited) and December 31, 2001

 

1

 

 

Consolidated Statement of Operations (Unaudited)
Three months ended March 31, 2002 and 2001

 

2

 

 

Consolidated Statement of Cash Flows (Unaudited)
Three months ended March 31, 2002 and 2001

 

3

 

 

Notes to Unaudited Consolidated Financial Statements

 

4

 

 

Management's Discussion and Analysis of
Financial Condition and Results of Operations

 

6

PART II—OTHER INFORMATION

 

9

Signatures

 

10

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ArQule, Inc.

Consolidated Balance Sheet (Unaudited)

(In thousands, except share data)

 
  March 31,
2002

  December 31,
2001

 
ASSETS
             
Current Assets:              
  Cash and cash equivalents   $ 42,129   $ 43,260  
  Marketable securities     48,525     51,070  
  Accounts receivable     1,812     1,772  
  Accounts receivable—related party     52     820  
  Inventory     687     625  
  Prepaid expenses and other current assets     1,732     1,440  
   
 
 
    Total current assets     94,937     98,987  
  Property and equipment, net     53,483     54,018  
  Non-current marketable securities     4,363     3,672  
  Intangible assets     19,667     20,511  
  Goodwill     25,889     25,889  
  Other assets     5,398     5,398  
   
 
 
    $ 203,737   $ 208,475  
   
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY              
Current liabilities:              
  Accounts payable and accrued expenses   $ 6,930   $ 7,515  
  Current portion of long-term debt     7,500     7,500  
  Deferred revenue     14,590     14,494  
  Deferred revenue-related party     263     113  
   
 
 
    Total current liabilities     29,283     29,622  
   
 
 
Long term debt     9,825     11,700  
Deferred revenue     4,447     414  
   
 
 
    Total liabilities     43,555     41,736  
   
 
 
Stockholder's Equity:              
  Common stock, $0.01 par value; 50,000,000 shares authorized; 21,155,764 and 21,116,419 shares issued and outstanding at March 31, 2002 and December 31, 2001, respectively     211     211  
  Additional paid-in capital     242,930     242,776  
  Accumulated deficit     (80,085 )   (71,710 )
  Deferred compensation     (2,707 )   (4,509 )
  Accumulated other comprehensive income     (167 )   (29 )
   
 
 
    Total stockholders' equity     160,182     166,739  
   
 
 
    $ 203,737   $ 208,475  
   
 
 

The accompanying notes are an integral part of these unaudited financial statements.

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ArQule, Inc.

Consolidated Statement of Operations (Unaudited)

(In thousands, except per share data)

 
  Three Months Ended
March 31,

 
 
  2002
  2001
 
Revenue:              
  Compound development revenue   $ 13,252   $ 12,285  
  Compound development revenue—related party     716     1,656  
   
 
 
    Total revenue     13,968     13,941  
   
 
 
Costs and expenses:              
  Cost of revenue     8,054     4,193  
  Cost of revenue—related party     220     2,338  
  Research and development     8,150     5,888  
  Marketing, general and administrative     3,664     2,520  
  Stock-based compensation     1,767     1,316  
  Amortization of intangibles     844     570  
  Amortization of goodwill         711  
  In-process research and development         18,000  
   
 
 
    Total costs and expenses     22,699     35,536  
   
 
 
    Loss from operations     (8,731 )   (21,595 )
Net investment income     356     1,339  
   
 
 
    Net loss   $ (8,375 ) $ (20,256 )
   
 
 
Basic and diluted net loss per share   $ (0.40 ) $ (1.07 )
   
 
 
Weighted average common shares outstanding—basic and diluted     21,082     18,971  
   
 
 

The accompanying notes are an integral part of these unaudited financial statements.

2



ArQule, Inc.

Consolidated Statement of Cash Flows (Unaudited)

(In Thousands)

 
  Three Months Ended
March 31,

 
 
  2002
  2001
 
Decrease in Cash and Cash Equivalents              
Cash flows from operating activities:              
  Net loss   $ (8,375 ) $ (20,256 )
Adjustment to reconcile net loss to net cash provided by (used in) operating activities:              
    Depreciation and amortization     2,332     2,000  
    Amortization of deferred compensation     1,767     1,462  
    Amortization of intangible assets     844     1,281  
    Purchase of in-process research and development         18,000  
    Decrease (increase) in accounts receivable     728     (3,196 )
    Increase in inventory     (62 )   (56 )
    (Increase) decrease in prepaid expenses and other current assets     (292 )   43  
    Decrease in other assets         1,504  
    Decrease in accounts payable and accrued expenses     (591 )   (1,305 )
    Increase (decrease) in deferred revenue     4,279     (2,296 )
   
 
 
      Net cash provided by (used in) operating activities     630     (2,819 )
   
 
 

Cash flows from investing activities:

 

 

 

 

 

 

 
    Purchases of marketable securities     (12,491 )   (17,549 )
    Proceeds from sale or maturity of marketable securities     14,213     19,357  
    Proceeds from tenant improvement allowance          
    Acquisitions, net of cash acquired         (1,523 )
    Purchase of property and equipment     (1,797 )   (21,363 )
   
 
 
      Net cash used in investing activities     (75 )   (21,078 )
   
 
 
Cash flows from financing activities:              
    Principal payments of capital lease obligation         (67 )
    Borrowings of long term debt         16,000  
    Principal payments of long-term debt     (1,875 )   (875 )
    Proceeds from issuance of common stock     189     246  
   
 
 
      Net cash (used in) provided by financing activities     (1,686 )   15,304  
   
 
 
    Net decrease in cash and cash equivalents     (1,131 )   (8,593 )
    Cash and cash equivalents, beginning of period     43,260     86,079  
   
 
 
    Cash and cash equivalents, end of period   $ 42,129   $ 77,486  
   
 
 
Supplemental disclosure of non-cash activity:              
    Net assets and liabilities assumed in Camitro acquisition.              

The accompanying notes are an integral part of these unaudited financial statements.

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ArQule, Inc.

Notes to Consolidated Financial Statements

1.    Organization and Nature of Operations

        ArQule, Inc. is engaged in the discovery, development and production of novel chemical compounds primarily for the pharmaceutical and biotechnology industries. Our operations are focused on the integration of high throughput automated chemistry, structure-guided rational drug design, computational and predictive models of drug-like compound characteristics and other proprietary technologies which automate the process of chemical synthesis to produce arrays of novel small organic chemical compounds used to generate and optimize drug development and product development candidates. We are subject to risks common to companies in the biotechnology, medical device and diagnostic industries, included, but not limited to, development by the Company or our competitors of new technological innovations, dependence on key personnel, protection of proprietary technology, and compliance with government regulations.

2.    Basis of Presentation

        We have prepared the accompanying consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to these rules and regulations. These consolidated financial statements should be read in conjunction with our audited financial statements and footnotes related thereto for the year ended December 31, 2001 included in our annual report on Form 10-K filed with the Securities and Exchange Commission on March 27, 2002. The unaudited consolidated financial statements include, in the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present fairly our financial position as of March 31, 2002, and the results of our operations for the three months ended March 31, 2002 and 2001. The results of operations for such interim periods are not necessarily indicative of the results to be achieved for the full year.

3.    Accounting Changes

        In June 2001, the Financial Accounting Standards Board issued FAS 142, Goodwill and Other Intangible Assets ("FAS 142"). Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed at least annually for impairment. With respect to goodwill amortization, ArQule adopted FAS 142 effective January 1, 2002. At March 31, 2002 and December 31, 2001, ArQule had goodwill of approximately $25.9 million. If ArQule chose not to implement the provisions of FAS 142 for goodwill, amortization expense for the three months ended March 31, 2002 would have been $1.1 million. Pursuant to FAS 142, ArQule will test for goodwill impairment at least annually and if impairment is indicated, record such impairment as a cumulative effect of accounting change effective January 1, 2002. ArQule is currently evaluating the effect that the impairment review may have on its consolidated results of operation and financial position.

4.    Camitro Corporation

        On January 29, 2001, we acquired Camitro Corporation; a privately held predictive modeling company based in Menlo Park, California in a transaction accounted for as a purchase business combination. The merger transaction was valued at $84.3 million based on our share price on the measurement date for the merger. Approximately $18.0 million of the purchase price represents the estimated fair value of the purchased in-process research and development ("IPR&D") that had not yet reached technological feasibility and had no alternative future use. Accordingly, this amount was immediately expensed in the consolidated statement of operations upon the acquisition date. The value

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assigned to IPR&D technology reflected the fair value of the initial suite of ADMET (absorption, distribution, metabolism, elimination, toxicity) models and the upgrade suite of ADMET models at the time of the merger.

5.    Pacific Shores Lease

        In connection with our acquisition of Camitro Corporation on January 29, 2001, we assumed Camitro's existing lease for approximately 25,000 square feet of office space in Menlo Park, California, which will expire on September 30, 2002. Prior to expiration, we had the option to renew this lease for a term of 18 months, which we have elected not to exercise. Our lease payments are $46,282 per month. Effective March 2002, we entered into an eight-year lease with Pacific Shores Centers LLC for approximately 34,000 square feet of laboratory and office space in Redwood City, California. We expect to take occupancy in September 2002. Our base lease payment, upon commencement will be approximately $75,823 per month, subject to annual escalation provisions. We will have the option to renew for an additional three-year term at the greater of the September 2010's rental rate or the then fair market value.

6.    Earnings (Loss) Per Share

        The computations of basic and diluted earnings (loss) per common share are based upon the weighted average number of common shares outstanding and potentially dilutive securities. Potentially dilutive securities include stock options and warrants. Options to purchase 1,266,265 and 1,384,177 shares of common stock were not included in the March 31, 2002 and March 31, 2001 computation of diluted net income (loss) per share, respectively, because inclusion of such shares would have an anti-dilutive effect on net loss per share.

7.    Contingencies

        We lease approximately 56,000 square feet of laboratory and office space in Medford, Massachusetts, the majority of which is utilized for the Pfizer collaboration. We lease these facilities under two lease agreements, one of which expires on July 30, 2005 and one of which expires on July 30, 2006. We sublease these facilities pursuant to three sublease agreements.

        On August 1, 2001, Cummings Properties, LLC ("Cummings") significantly raised our rent on the lease that expires July 30, 2006. We believe this increase to be in excess of rates that are permissible under the lease agreement. Accordingly, on January 16, 2001, we brought a complaint to Middlesex Superior Court of The Commonwealth of Massachusetts for declaratory relief and damages against Cummings arising, in part, out of Cummings' attempts to increase our lease rates. Nevertheless, during the pendency of this dispute, we are paying the rental rate proposed by Cummings. We seek recovery of the funds that we have already paid and are paying, under protest. If the amount of rent we must pay is in excess of our current estimate of market rates, we will need to recognize additional expense.

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ArQule, Inc.

Management's Discussion and Analysis of Financial Condition
and Results of Operation

OVERVIEW

        We are engaged in the production and development of novel chemical compounds with commercial potential in the pharmaceutical and biotechnology industries. We primarily manufacture arrays of synthesized compounds for delivery to our customers for use in lead compound generation and lead compound optimization activities. In addition, we have established a number of joint drug discovery programs with biotechnology companies and academic institutions, and are pursuing a limited number of our own internal drug discovery programs.

        We primarily generate revenue through our collaborative agreements for production and delivery of compound arrays and other research and development services. Under some of these collaborative agreements, we are also entitled to receive milestone and royalty payments if the customer develops products resulting from the collaboration. To date, we have received two milestone payments and no royalty payments. In addition, we have not yet realized any significant revenue from our joint discovery programs with biotechnology companies and academic institutions, or from our internal drug discovery programs. While we expect our revenue to increase in 2002, our financial performance may vary from expectations, including quarterly variations in performance, because levels of revenue are dependent on expanding or continuing existing collaborations, entering into additional corporate collaborations, receiving future milestones and royalty payments, and realizing value from ongoing drug discovery programs, all of which are difficult to anticipate. See the discussion of our revenue recognition policy in our Critical Accounting Policies in our annual report on Form 10-K filed on March 27, 2002.

        We will continue to invest in technologies that enhance and expand our capabilities in drug discovery. These continued investments in technology are intended to enhance the novelty, diversity, and medical relevance of our compound arrays and to augment the power and scope of our chemistry capabilities. In addition to investments in technology, we may invest in internal lead optimization programs with the goal of delivering clinical candidates. Investments of this nature may result in near term earnings fluctuations or impact the magnitude of profitability or loss.

        We have incurred a cumulative net loss of $80.1 million through March 31, 2002. Losses have resulted principally from costs incurred in research and development activities related to our efforts to develop our technologies and from the associated administrative costs required to support those efforts. While we were profitable in fiscal year 2000, we were not profitable in 2001 and we expect that we will not be profitable in 2002. Our ability to achieve sustained profitability is dependent on a number of factors, including our ability to perform pursuant to our collaborations at the expected cost, our ability to expand or continue existing collaborations, the timing of additional investments in technology and the realization of value from the development and commercialization of products in which we have an economic interest, all of which are difficult to predict.

        The Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements reflecting management's current expectations regarding our future performance. These statements can generally be identified by the use of forward-looking words such as "believe," "expect," "plan," "intend," "may," "will," "should," "anticipate," or similar words and phrases. Forward-looking statements reflect management's current expectations, which are based on certain assumptions regarding revenue growth and profitability, the progress of product development efforts under collaborative agreements, execution of new collaborative agreements, our development of technology invented in-house and acquired from Camitro and elsewhere, and other factors relating to our growth. Such expectations may not materialize. Actual results could differ materially from those anticipated if, among other things, product development efforts are delayed or suspended, negotiations

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with potential collaborators are delayed or unsuccessful, or if other assumptions prove to be incorrect. For a complete description of risks and uncertainties that may cause actual results to differ materially from management's current expectations, please refer to our annual report on Form 10-K filed on March 27, 2002. We will not update any forward-looking statements to reflect events or circumstances that occur after the date of that report, except as may be required by law.

RESULTS OF OPERATIONS

Three Months Ended March 31, 2002 and 2001

        Revenue.    Total revenues for the three months ended March 31, 2002 were $14.0 million, as compared to $13.9 million for the same period in 2001, an increase of $0.1 million, or approximately 1 percent. This increase is primarily due to Custom Array library revenues from the new Pfizer agreement offset by the decrease in revenues due to the completion of the Wyeth and Johnson & Johnson Mapping Array Programs.

        Cost of revenue.    Cost of revenue for the three months ended March 31, 2002 totaled $8.3 million, as compared to $6.5 million for the same period in 2001, an increase of $1.8 million, or approximately 28 percent. The increase in costs of revenue was attributable to increased costs for producing Custom Array sets for Pfizer Inc. and Bayer AG. Our gross margin as a percentage of sales was 41 percent for the period ended March 31, 2002, as compared to 53 percent for the same period during the prior year. Our gross margin as a percentage of sales was lower in 2002 due to increased costs related to the Bayer and Pfizer collaborations.

        Research and development expenses.    Research and development expenses for the three months ended March 31, 2002 were $8.2 million, as compared to $5.9 million for the same period in 2001, an increase of $2.3 million, or 39 percent. This increase is the result of our ongoing efforts to augment and enhance our chemistry, predictive and computational modeling capabilities and related proprietary technologies, including increases in personnel, as we expand our drug discovery programs and technology platform.

        Marketing, general and administrative expenses.    Marketing, general and administrative expenses for the three months ended March 31, 2002 were $3.7 million, as compared to $2.5 million for the same period in 2001, an increase of $1.2 million, or 48 percent. The increase was primarily associated with increased support costs, including added personnel.

        Merger Related Charges.    Expenses for the first quarter of 2001 related to our acquisition of Camitro were $20.6 million, which included a one-time charge of $18.0 million for in-process research and development, $1.3 million for stock-based compensation, $0.7 million for the amortization of goodwill and $0.6 million amortization of other intangibles. Expenses for the first quarter of 2002 include $0.8 million in amortization of other Camitro intangibles and $1.7 million in stock-based compensation expense.

        Net investment income.    Net investment income consists primarily of interest income partially offset by interest expense and other non-operating income and expenses. Interest income in for the three months ended March 31, 2002 was $0.6 million, as compared to $1.6 million for the same period in 2001, a decrease of $1.0 million. Interest expense was $0.3 million in 2002 and 2001. Our lower investment income in 2002 is a result of lower average interest rates on our investment portfolio when compared to 2001.

        Net loss.    Our net loss for the three months ended March 31, 2002 was $8.4 million, compared to a net loss of $20.3 million for the same period in 2001. Our net loss in 2001 was primarily attributable to $20.6 million in merger-related amortization and charges from our acquisition of Camitro.

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LIQUIDITY AND CAPITAL RESOURCES

        At March 31, 2002, we held cash, cash equivalents and marketable securities with a value of $95.0 million, compared to $98.0 million at December 31, 2001. Our working capital at March 31, 2002 was $65.7 million. We have funded operations through March 31, 2002 with sales of common stock, payments from corporate collaborators, and the utilization of bank financing.

        Cash flows provided by operating activities for the period ended March 31, 2002 were $0.6 million, an increase of $3.4 million from $2.8 million used in 2001. This increase reflects primarily the timing of payments from our corporate collaborations. Cash flows used in investing activities for the period ended March 31, 2002 were $0.1 million compared to a use of cash of $21.1 million in the same period of 2001. The principal reason for this change was our purchase of our facility and the adjacent lot in Woburn, Massachusetts for $20.5 million in March 2001. Cash flows generated from financing activities for the period ended March 31, 2002 decreased $17.0 million to $1.7 million used in 2002 from $15.3 million generated in 2001. In March 2001, we borrowed $16.0 million from Fleet to finance our facility and land purchase.

        We expect that our available cash and marketable securities, together with operating revenues and investment income will be sufficient to finance our working capital and capital requirements for the next several years. We have been cash flow positive from operations for three consecutive years, and coupled with our existing cash and marketable securities, we believe that even without additional funding we would have sufficient funds to operate for at least the next several years. Our cash requirements may vary materially from those now planned depending upon the results of our drug discovery and development strategies, our ability to enter into any additional corporate collaborations in the future and the terms of such collaborations, the results of research and development, the need for currently unanticipated capital expenditures, competitive and technological advances, acquisitions and other factors. We cannot guarantee that we will be able to obtain additional customers for our products and services, or that such products and services will produce revenues adequate to fund our operating expenses. If we experience increased losses, we may have to seek additional financing from public or private sales of our securities, including equity securities. There can be no assurance that additional funding will be available when needed or on acceptable terms. Our contractual obligations as of March 31, 2002 and the effect such obligations are expected to have on its liquidity and cash flows have not changed materially, except for the lease described in Note 5 above, since December 31, 2001.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We own financial instruments that are sensitive to market risk as part of our investment portfolio. Our investment portfolio is used to preserve our capital until it is used to fund operations, including our research and development activities. None of these market-risk sensitive instruments is held for trading purposes. We invest our cash primarily in money market mutual funds and U.S. government and other investment grade debt securities. These investments are evaluated quarterly to determine the fair value of the portfolio. Our investment portfolio includes only marketable securities with active secondary or resale markets to help insure liquidity. We have implemented policies regarding the amount and credit ratings of investments. Due to the conservative nature of these policies, we do not believe we have material exposure to market risk.

        Our use of derivative financial instruments is limited to the utilization of two interest rate swap agreements. Settlement accounting is used for these interest rate swaps, whereby amounts to be paid or received under the interest rate swap agreements are accrued as interest rates changes and are recognized as an adjustment in interest expense.

        See notes 2 and 9 to the consolidated financial statements in our 2001 Annual Report on Form 10-K filed March 27, 2002 for a description of our use of derivatives and other financial instruments. The carrying amounts reflected in the consolidated balance sheet of cash and cash equivalents, trade receivables, and trade payables approximates fair value at March 31, 2002 due to the short-term maturities of these instruments.

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ArQule, Inc.

PART II—OTHER INFORMATION

Item 1 — Legal Proceedings

        This information as set forth in Note 7 of "Notes to Consolidated Financial Statements" appearing in Item 1 of Part 1 of this report is incorporated herein by reference.

Item 2 - 5—None.

Item 6(a)—Exhibits:

Exhibits

  Description
10.40   Lease by and between Pacific Shores Center LLC and the Company, dated March 1, 2002. Filed herewith.

Item 6(b)—Reports on Form 8-K—None

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ArQule, Inc.

Signatures

        Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

    ArQule, Inc.

Date: May 15, 2002

 

/s/  
DAVID C. HASTINGS      
David C. Hastings
(Vice President, Chief Financial Officer and Treasurer)

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ArQule, Inc.

Exhibit Index

Exhibit No.

  Description

 

 

 
Item 6(a)—Exhibits:

10.40

 

Lease by and between Pacific Shores Center LLC and the Company, dated March 1, 2002. Filed herewith.



QuickLinks

ArQule, Inc. Quarter Ended March 31, 2002 Table of Contents
ArQule, Inc. Consolidated Balance Sheet (Unaudited) (In thousands, except share data)
ArQule, Inc. Consolidated Statement of Operations (Unaudited) (In thousands, except per share data)
ArQule, Inc. Consolidated Statement of Cash Flows (Unaudited) (In Thousands)
ArQule, Inc. Notes to Consolidated Financial Statements
ArQule, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operation
ArQule, Inc.
Signatures
Exhibit Index